The Competitiveness of Armenia’s Private Sector: Moving to the Next Stage

1. Economy and Values Research Center Manuk Hergnyan Gagik Gabrielyan Anna Makaryan The Competitiveness of Armenia’s Private Sector: Moving to the Next Stage Washington, 2008 The presentation is based on the results of the first National Competitiveness Report of Armenia

2. Presentation Highlights NATIONAL COMPETITIVENESS REPORT THE CHALLENGE OF COMPETITIVENESS ARMENIA’S COMPETITIVENESS SCORECARD CURRENT ECONOMIC PERFORMANCE OF ARMENIA DRIVING FORCES BEHIND THE PERFORMANCE TOWARDS A COMPETITIVE ECONOMY

3. The Report • For the third year Armenia is included in the Global Competitiveness Report (GCR) of the World Economic Forum (WEF). • Economy and Values research center as the partner organization of the WEF has initiated the preparation of the first National Competitiveness Report. • The first National Competitiveness Report of Armenia (ACR) analyses the economic situation and performance of Armenia in the context of competitiveness. • The Report will be launched in two weeks.

4. Goals and Objectives of the Report The goal To develop a premium tool for analysing economic competitiveness of Armenia. Objectives • Evaluate competitiveness of Armenia’s economy; • Identify challenges and priorities for Armenia; • Identify competitive advantages of Armenia and opportunities for improving competitiveness; • Recommend strategic approaches and key levers for tackling challenges and capturing opportunities. Role • High quality data and analysis for public and private sector leaders • A helpful tool for a dialogue between the government and the private sector; • Ample material for university faculty members, students and researchers; • A message to the international community that Armenia is committed to becoming an internationally competitive country.

5. Presentation Highlights NATIONAL COMPETITIVENESS REPORT THE CHALLENGE OF COMPETITIVENESS ARMENIA’S COMPETITIVENESS SCORECARD CURRENT ECONOMIC PERFORMANCE OF ARMENIA DRIVING FORCES BEHIND THE PERFORMANCE TOWARDS A COMPETITIVE ECONOMY

6. Importance of Competitiveness • Competitiveness is based on the nation’s capabilities and not its natural resources. • Competitiveness is the source of prosperity for the citizens of the country. • Competitiveness is the outcome of innovation and technological advancement and, at the same time, the driving force behind them. • Competitiveness ensures increasing productivity of the companies in the country and their capability of competing in the international market.

7. Definition of Competitiveness • The definition of Scott and Lodge (1985) views competitiveness as a capability of the nation to produce goods and service and distribute internationally. • Porter’s definition (1990) underscores the productivity with which the nation utilizes its resources – focus on microeconomic basis. • Xavier Sala-i-Martin’s (2004) definition underscores combination of macroeconomic and microeconomic factors including policies and institutions that determine the level of productivity and define the sustainable level of prosperity in a mid-term. • ACR draws on these three definitions of competitiveness.

8. Competitiveness Rankings • Internationally recognized organizations that offer country competitiveness rankings: • The World Economic Forum (WEF), • The Institute for Management Development ( IMD), • The Institute for Industrial Policy Studies (IPS). • WEF Global Competitiveness Report -GCR • A leading and most comprehensive source for ranking country competitiveness; • uses both statistical data and “soft data” (executive opinion surveys). • GCR has two measurement indexes: • Business Competitiveness Index (BCI) that measures the quality of business environment and the level of sophistication of company strategies and operations. • Global Competitiveness Index (GCI) which has a wider coverage and includes macroeconomy, healthcare and education. • Armenia is only covered by the WEF reports

9. Presentation Highlights NATIONAL COMPETITIVENESS REPORT THE CHALLENGE OF COMPETITIVENESS ARMENIA’S COMPETITIVENESS SCORECARD CURRENT ECONOMIC PERFORMANCE OF ARMENIA DRIVING FORCES BEHIND THE PERFORMANCE TOWARDS A COMPETITIVE ECONOMY

10. Armenia’s Ranking in the GCR: the 93rd among 131 Countries • Armenia’s ranking has declined though its absolute scores have slightly increased. • Armenia’s ranking is relatively high in the macroeconomic, healthcare and primary education areas. • However, at the micro-level Armenia’s indicators are rather low. With it Business Competitiveness Index Armenia is the 108th. • Main problems are: • Imperfectness of business environment; • Low level of business sophistication; • Unsatisfactory level of higher education and training; • Poor cooperation between businesses and supporting institutions; • Low level of innovation.

11. Global Competitiveness Index Composition

12. Armenia's Ranking in the GCROn Basic Requirements Armenia’s Ranking is Relatively Favorable Institutions - 96 Infrastructure - 87 • Public institutions are better developed than the private ones. • Public institutions - 77 • Relatively higher security level • Lack of judiciary independence • Protectionism in government decisions • Low trust towards politicians • Private institutions - 102 • Poor ethics • Low accountability • Lack of protection of interests of minority shareholders • Low level of maintaining financial audit and reporting standards • Poor indicators despite the improvements in recent years. • One of the major obstacles for the private sector. • The telecommunication is poorly developed. • Lack of a port considerably worsens Armenia’s ranking.

13. Armenia's Ranking in the GCROn Basic Requirements Armenia’s Ranking is Relatively Favorable Macroeconomy - 57 Healthcare and primary education - 99 • High economic growth • Low inflation • Improved national budget system • Effective management of government debt • Low level of savings • Large interest rate spreads • Fluctuations of the exchange rate of dram in the recent years • Unequal regional development • Unequal distribution of wealth • Decreasing infant mortality • The impact of tuberculosis, HIV/AIDS and similar diseases on businesses is not significant • Relatively high level of enrollment in primary education

14. Armenia's Ranking in the GCROn Basic Requirements Armenia’s Ranking is Relatively Favorable Goods market efficiency - 104 Labor market efficiency - 40  Liberal trade regime is not an obstacle for efficiency of local market  Weak anti-monopolistic policy, limited nature of competition in the local market •  Flexibility in defining salaries and wages •  Flexible relations between employers and employees •  Lack of well-trained leaders Financial market sophistication- 110 Market size- 111  Underdeveloped financial markets  Difficulties to obtain loans (high interest rates, excessive collateral requirements)  Underdeveloped securities market  Lack of venture market • Limited domestic market size • Small-scale foreign market size

15. Armenia's Ranking in the GCRArmenia’s Ranking in Efficiency Enhancers is Weak Technological readiness - 104 Higher education and training - 95 • Local companies have developed capacities to absorb new technologies •  Foreign direct investments are not the major source for transferring new technologies •  Imperfectness of the legislative framework conducive to wide application of IT •  High level of enrollment in secondary education •  Continuous decline in number of people with higher education •  Decreasing quality of education system •  Very low level of the quality of business education • Low quality of instruction in mathematics and sciences • Lack of specialized trainings, R & D services • Low spending of companies for training

16. Armenia's Ranking in the GCRArmenia’s Ranking in Innovation is Weak Business Sophistication - 111 Innovation - 94 • Lack of local specialized supplier and their relatively low quality • Production process based on intensive use of labor force and old generation technologies • Application of the simplest forms of marketing tools • High level of centralization of management decisions • Competitive advantages driven by low cost • Simple value chains • Relatively high number of patents registered with the U.S. in comparison with other countries • Low level of quality of research institutions • Low spending on R&Dby privatecompanies • Weak cooperation between private sector and universities • Lack of state policy of procurement of high technologies • Weak IPR protection • Not widespread practice of obtaining new technologies by licensing or copying.

17. Presentation Highlights NATIONAL COMPETITIVENESS REPORT CHALLENGE OF COMPETITIVENESS ARMENIA’S COMPETITIVENESS SCORE CURRENT ECONOMIC PERFORMANCE OF ARMENIA DRIVING FORCES BEHIND THE PERFORMANCE TOWARDS A COMPETITIVE ECONOMY

18. Competitiveness Ensures the Basis for Prosperity Prosperity is a choice. It is a choice between the alternatives of strategies and operations for efficient use of available resources and knowledge. Source: EV (2007) adapted from M. Porter (1998)

19. Three Sets of Countries are Selected for Benchmarking CIS Central, Eastern and Southeastern Europe Eurasian Crossroad Rationale Common historical context, similar economic conditions, close economic ties 10 countries Russia, Ukraine, Kazakhstan, Moldova, Belarus, Georgia, Azerbaijan, Uzbekistan, Kirgizstan, Tajikistan Rationale Considerable successes in the transition period. Perceived as a region including Armenia. 15 countries Latvia, Lithuania, Estonia, Poland, Hungary, Czech Republic, Slovenia, Slovakia, Bulgaria, Romania, Bosnia, Albania, Serbia, Croatia, Macedonia Rationale Historic region encompassing Armenia, geographic crossroad on important Eurasian trade routes. 8 countries Turkey, Azerbaijan, Georgia, Iran, Syria, Lebanon, Israel, Jordan

20. PRODUCTIVITYArmenia ranks low in terms of labor force participation and general productivity of labor force and is behind the majority of comparator countries Source: WB, WDI * The small chart on the leftt hand corner compares Armenia’s performance (production per employee) with that of Ireland (Ireland = 100).

21. PRODUCTIVITYThe situation is even worse in manufacturing. Source: WB, WDI

22. INTERNATIONALIZATIONArmenia is in good position in terms of its export share growth in the global exports, however, in absolute terms it is still behind most of the comparator countries. Armenia’s share in global exports is less than its share in global GDP. Source: WB, WDI, UNCTAD * The small chart on the right hand corner compares Armenia’s performance (share of export in global exports) with that of Ireland (Ireland = 100).

23. INTERNATIONALIZATIONResource-intensive (raw materials) export share is substantially high in Armenia’s total exports, while share of high value added export is very small. Export structure is very centralized. Source: WB, WDI, UNCTAD * The small chart on the right hand corner compares Armenia’s performance (non-mineral and non-raw material share of export) with that of Ireland.

24. INTERNATIONALIZATIONArmenia has average position in terms of attracting FDI. However, Armenia is behind most of the countries in terms of FDI per capita. The strategy of attracting FDI driven by privatization and infrastructure deals needs profound revision. Source: WB, WDI, UNCTAD * The small chart on the right hand corner compares Armenia’s performance (per capita FDI, 2000-2005 (average)) with that of Ireland (Ireland = 100).

25. KNOWLEDGEArmenia has not been able to recover its former capacities in R&D area. Very little expenses are being made in R&D. However, relatively large number of patents vs. expenditures were registered. Source: WB, WDI, USPTO * The small chart on the right hand corner compares Armenia’s performance (number of patents registered in the USA per one million persons) with that of Ireland (Ireland = 100).

26. Presentation Highlights NATIONAL COMPETITIVENESS REPORT CHALLENGE OF COMPETITIVENESS ARMENIA’S COMPETITIVENESS SCORE CURRENT ECONOMIC PERFORMANCE OF ARMENIA DRIVING FORCES BEHIND THE PERFORMANCE TOWARDS A COMPETITIVE ECONOMY

27. FOUNDATIONS OF COUNTRY COMPETITIVENESS Favorable macroeconomic environment is a necessary but not sufficient precondition for achieving high level of competitiveness. Source: M. Porter

28. MACROECONOMIC ENVIRONMENT Armenia’s macroeconomic environment is rather favorable. Positive achievements Distortions • Liberal economic environment • Privatization and dominance of private sector • High rate of economic growth • Low inflation • Manageable level of fiscal deficit • Quite satisfactory budget system • Significant fluctuations of exchange rates • Significant difference (spread) between the interest rates for deposits and loans

29. MACROENVIRONMENT Legal and Institutional Environment Political Environment Social Environment • X The stability of political situation is shaken by recent post-election events • Many global investors still view Armenia as a country in war • Social situation is improving relatively fast. • Real level of poverty and unemployment (above 30%) is still high • Regional development is extremely disproportionate; • Distribution of wealth is unequal; • Salary range is still lower than the level in 1990 • Comprehensive legislative framework consistent with the WTO and other international requirements • There are serious issues with enforcement of legislation; • Imperfect secondary legislation; • Ambiguous procedures; • Unsatisfactory human and institutional capabilities • Insufficient independence of the judiciary

30. MICROENVIRONMENT The most serious competitive disadvantages of Armenia are on the micro level. • Wealth, after all, is created by companies and not due to the best combination of macroeconomic indicators. • The level of strategies and operations of companies defines their capability for competing and long-term profitability. • On the other hand, they are driven by its immediate environment, i.e. business environment.

31. MICROENVIRONMENTOn the conceptual side Porter’s “diamond” model is used for studying the microenvironment of the economy.

32. MICROENVIRONMENTFactor Assessment Physical infrastructure Administrative infrastructure Human capabilities Scientific and technological infrastructure • Improved power supply • Improved air and land transportation infrastructure • Developments in telecommunication • Weak telecommunication infrastructure • Lack of a harbor • Improved bureaucracy • Sufficient security • Inefficient legal framework • Dependent judiciary • Low quality specialists • Inefficiency of the educational system • Lack of high quality management schools • Progress in obtaining U.S. patents • Low quality of R&D institutions • Weak cooperation between businesses and R&D institutions • Low level of spending for R&D institutions

33. MICROENVIRONMENTFinancial sector is currently one of the major “constraints” of the Armenia’s business environment. Financial system’s participation in economic life is limited. Source: WB, WDI * The small chart on the right hand corner compares Armenia’s performance (local lending through bank system, 2005 (GDP%)) with that of Ireland (Ireland = 100).

34. MICROENVIRONMENT Root Causes of Financial Intermediation Demand • Structure of the Economy • Financing of large foreign companies from external sources • Opportunities for funding from internal sources from “informal tax privileges” • large share of small agricultural producers • Large share of construction, which is mostly funded by advance payments and private transfers • Shadow economy Supply • Low and unequally distributed revenues => small savings • Low trust toward financial institutions • Lack of institutions accumulating “long” money; weak ties with international markets • High level of risk for overall economy => expensive capital Regulation and Mediation • Competitiveness is restricted to several sections • Tough regulation • Legal issues, weak mechanisms for sale of pledged collateral => tough collateral requirements

35. MICROENVIRONMENT Demand factors: the existing demand both in public and private sector still lack the quality to serve as an incentive for sophistication of goods and services. Lack of specific demand Weak pressure on businesses Weak incentives for sophistication Simple business procedures • The impact of state procurement is also insignificant. • Standards and other regulatory requirement have been improved but still do not have a serious impact.

36. MICROENVIRONMENT Related and Supporting Industries • Limited information flow and lack of integration between the enterprises, suppliers and buyers • Weak connections with other industries • Underdeveloped support institutions • Extreme need for professional training centers • Very limited flow of information within industries Lack of Strong Clusters Given numerous synergetic impact the clusters are considered to be the source of competitive advantages. This fact is not fully recognized in Armenia.

37. MICROENVIRONMENT Fundamental issues exist in corporate management and internal competition. Drivers Internal Competition • Relatively good relations between employers and employees • Protectionism in government decrees • Lack of corporate management practices • Inadequate reporting • No protection of interests of minority shareholders • Weak IPR protection. • External trade administration is relatively liberal • The impact of corruption on businesses is not prohibitive • Fragmentation of local competition (extremely differs by sector or market segment) • Dominance of powerful groups in selected mass markets • Weak protection of economic competition

38. MICROENVIRONMENTPoor strategies of companies account for their most significant competitive disadvantages. • Not ready to delegate • Shortage of professional management Business administration • Enterprises are willing to use new technologies but make little spending on R&D • Production processes and operations are not sophisticated Production operations • Low spending on education and training of employees Labor Force • Companies do not use advanced tools for marketing and do not establish international distribution networks Marketing and international sales Global competitiveness • Limited industries are internationally competitive • Companies do not master profoundly the tactics for competing in international markets

39. Diagnostic SummaryThe economy is growing, but the competitiveness is falling. “The Growth-Competitiveness” Paradox

40. Presentation Highlights NATIONAL COMPETITIVENESS REPORT CHALLENGE OF COMPETITIVENESS ARMENIA’S COMPETITIVENESS SCORE CURRENT ECONOMIC PERFORMANCE OF ARMENIA DRIVING FORCES BEHIND THE PERFORMANCE TOWARDS A COMPETITIVE ECONOMY

41. BUILDING COMPETITIVENESSThe issue of competitiveness assumes different approaches in the short- and in the long-run. Long-term Short-term Quick Wins Strategic Breakthrough • Quick wins, even if small, serve as an incentive to strive for long-term strategic • Create basis for coalitions for changes • Allow to quickly improve Armenia’s international rankings • Strategic targeting assumes building a holistic picture • Allows to identify the criteria for assessment of different actions • Makes comprehensible the directions of reform initiatives • Establishes a sustainable competitive advantage

42. BUILDING COMPETITIVENESS Quick wins and strategic breakthrough address different issues. • Certain improvement of current competitiveness position can be achieved very quickly through several initiatives and improvements • However, regional and international competitiveness new, “higher level” of actions are required with the timeframe of 10-12 years. Quick Win Quick Win Time

43. QUICK WINS Short-term priorities can be identified by using a newly developed tool called “Prioritization filter”.

44. IDENTIFIED QUICK WINS

45. STRATEGIC TARGETING Strategic targeting assumes presentation of main value proposal as the basis for the main regional role.

46. THE SYSTEM OF COMPETITIVE LEVERS (LEVERAGE) To ensure sustainability of respective positioning and to gain advantages in regional competition it is necessary to identify the key competitive levers.

47. BASIS FOR LEVERSThe system of levers should be used in addition to the general economic policy. • The basis for levers is a three-component system that will establish an efficient context for applying the levers. • The central role is prescribed to the cluster policy, which should become a model for organizing the economic system rather than a set of isolated initiatives in selected areas. • Economy should be viewed as a group of clusters. • Clusters should be upgraded based on the main value proposition. • Cluster policy becomes the link between the innovation policy and the regional development policy. • The three components are coordinated together and support each other.

48. LEVERSCompetitive levers are the selected factors that would ensure the strategic breakthrough. FDI should become a source for large scale investments and transfer of technology into Armenia. In addition, it will improve the competitiveness through expansion in international sector. With relevant policy background the use of the Diaspora resources may become focused, cluster-specific and aligned with innovation and regional development policies. Education in Armenia may not be only a general factor for improving competitiveness, but also basis for regional positioning.

49. IMPLEMENTATION The logic behind levers assumes a renewed institutional approach. • The use of the leverage system may be efficient in a relevant organizational and institutional environment. • Renewed institutional approach firstly assumes modernization of existing institutions and in some instances establishment of new ones • In the context of introducing key levers it is important to involve large investors and Diaspora representatives in such institutions.

50. COMPETITIVENESSIncreased competitiveness is as vital for Armenia as its national security. Renewed strategic approaches Competitiveness Renewed institutional approaches